DELL: Goldman Ups to Buy; Barclays Sees Maintenance Rev at Risk

By Tiernan Ray

Shares of Dell (DELL) are up 65 cents, or almost 7%, at $10.30, after Goldman Sachs hardware analyst Bill Shope this morning raised his rating on the shares to Buy from Sell, with a $13 price target, writing that a 31% drop in the share price since December 12th of 2010, when he started following the stock, has placed the shares in “deep value” territory, with an enterprise value-to-Ebtida multiple of just three times, almost half off the valuation of other hardware names.

By his reckoning, a higher multiple is deserved, perhaps 4 times.

The stock, trading at just six times his fiscal 2013 estimate of $1.69 in adjusted EPS, is supported by $3 per share in cash, or roughly $5.2 billion in net cash, notes Shope.

The central concern Shope still holds is the deterioration of the PC market, but he this that the trendily is sufficiently reflected in the consensus Street opinion at this point:

Over the past two years we have urged investors to avoid “deep value” technology stocks, particularly those with outsized exposure to the PC, server and printing end markets. Nevertheless, we believe many of our secular concerns over these market segments and Dell in particular have now become consensus. With this in mind, we now believe that Dell has become an attractive deep value play and we would be buyers of the stock.

That matters because it means the estimates may be low enough now to keep Dell from drastically disappointing:

As such, in order to become more bullish on a deep-value hardware name, we need to have some comfort that investor expectations and sentiment are reasonably depressed on a company’s near- to medium-term earnings prospects […] Our earnings estimates for Dell have been below consensus since we assumed coverage in December 2010. With the recent spate of downward revisions, however, the downside risk to consensus expectations has narrowed. Consensus expectations for Dell for FY2014 (CY2013) are down 28% from their peak and at their lowest levels of the year. Our current forecast for FY2014 calls for EPS of $1.53, which is just $0.13 below consensus and one of the narrowest differentials this year. Though we still see downside to published consensus, our sense is that investors are already expecting earnings closer to our forecast, where we see the downside risk as being more limited.

There’s also the prospect that Dell’s cash could bring a leveraged buyout or another financial restructuring:

Dell has the option to take advantage of its healthy balance sheet for strategic purposes, something that other net debt hardware names do not have in their favor. With Dell shares trading at such a discounted valuation, the company’s sizeable cash position, and Michael Dell’s previous public comments about taking the company private, we built a model to help gauge the potential viability and attractiveness of a Dell LBO. Our results indicate that a Dell LBO transaction would be difficult given the tax impact on foreign cash and the large deal size, but potential involvement by CEO and founder Michael Dell (who already owns 14% of Dell shares) makes it difficult to completely dismiss an LBO transaction entirely. Either way, we believe that LBO considerations will help provide a floor for shares, as the IRR becomes increasingly attractive (even given our conservative assumptions on foreign held cash) as Dell’s stock price approaches $9.

On the other hand, Barclays Capital‘s own hardware analyst, Ben Reitzes, also released a note today on Dell, reiterating an Equal Weight rating and a $10 price target, and writing that the company has yet to face the threat of a decline in its maintenance services revenue.

Maintenanc on PCs is a third of Dell’s revenue and if it starts to fall, in line with PC sales, it could seriously trim EPS, he writes:

While PC units and revenues have declined rapidly of late, Dell’s PC maintenance business has actually grown over the last 3 quarters. If this maintenance stream starts to fall 15% annually – i.e., about the same rate that PC revenues fell the last two quarters – we calculate that Dell would lose $0.12 in annualized EPS power or about 7% of total earnings. We estimate that the PC maintenance stream accounts for about 30% of Dell’s total earnings […] If this EPS power was lost, it could point toward lower estimates in the future – and partially explains our non-GAAP EPS estimate for FY14 of $1.40 (below consensus of $1.68) and our FY15 estimate of $1.25 (well below consensus of $1.69).

About Tech Trader Daily

Tech Trader Daily is a blog on technology investing written by Barron’s veteran Tiernan Ray. The blog provides news, analysis and original reporting on events important to investors in software, hardware, the Internet, telecommunications and related fields. Comments and tips can be sent to: techtraderdaily@barrons.com.